As we continue to build Hedge, 0% interest lending on Solana, we’re excited to announce a new form of reward for liquidity providers: HDG options!
Starting Sep 12th 2022, Hedge is partnering with Zeta Markets to offer HDG options as part of the rewards for liquidity providers on Raydium. For those not familiar with options, this post provides a brief intro. If you’re just interested in details about the rewards, you can find those at the bottom of the post.
Intro to Options
What is an option?
In this post, we’ll be focusing on call options, which give you the right to buy an asset at a predetermined price within a certain time period.
For instance, you could hold an option on HDG that allows you to pay $2 for a token any time within the next year. If the price went way above $2 during that time, you could buy HDG cheaper than you could on the market. If the price stayed below $2, you wouldn’t do anything and could let the option expire for free.
Every option has two important details: a strike price and an expiration.
The strike price is the price it costs to exercise the option, i.e. how much you have to pay per token. The strike price in the example above would be $2. When the current price of an asset is above the strike price, the option is in the money because you could exercise it and make a profit. If the current price is below the strike price, it is out of the money, and it’s likely you wouldn’t exercise the option.
The expiration is the deadline for exercising the option. The expiration in the example above would be one year in the future. Letting options expire costs you nothing and gains you nothing.
Why would I want options?
In the case of our liquidity pool rewards, options allow you to earn greater profits if the price of HDG goes up enough. However, that gain is balanced by the risk of receiving nothing if your options expire out of the money.
Option rewards allow you to earn more because Hedge applies a risk-based multiplier to the options rewarded by the liquidity pool, boosting the number you receive (see below for more detail).
Let’s make the example above more concrete and compare receiving options as rewards vs receiving HDG tokens.
Assume HDG is currently at $1. Let’s say you receive 400 HDG options with a $2 strike price and an expiration date one year in the future. You also receive 100 HDG. Note that your options are out of the money to start and you received 4x more options to simulate the multiplier.
Case 1: HDG goes up to $4
Your options are now in the money. If you exercise them, you can buy 400 HDG for just $2. You’ll pay $800 to exercise and receive 400 HDG worth $1600, giving you $800 of immediate profit.
For comparison, the 100 HDG you received is worth $400.
Case 2: HDG drops to $.5 and stays there until the options’ expiration date
Your options are still out of the money. Exercising your options would force you to overpay, so if you did want HDG, you would usually do better by just buying it on the market. At the end of the year, you let your options expire, which costs you nothing. You net $0.
For comparison, the 100 HDG you received is worth $50.
In the bull case, your options gave you a nice profit. You received a lot of HDG for a low price, and you were better off receiving options than tokens.
In the bear case, your options were worthless and you received no HDG from them, but you didn’t lose anything holding them. However, in this case, you would have been better off just receiving tokens.
Of course, you can’t know the outcome beforehand, so the decision comes down to your sense of risk and reward.
An option that’s in the money has some obvious value. It can be exercised at any time, and you immediately make a profit equal to the difference in the asset price and the strike price.
However, out-of-the-money options are not necessarily worthless. There’s a possibility the HDG price will go over the strike price before expiration (as in Case 1 above), at which point they can be exercised for profit. Considering factors like the current price, the time left before expiration, and the volatility in the price of HDG can be useful for understanding the expected value of your options.
For instance, if you considered the two situations above as equally likely, your expected value for taking the options would be $400, while the expected value of the tokens would be $225.
Offering HDG options as liquidity rewards
Starting Sep 12th 2022, the Raydium HDG-USDC pool will reward liquidity providers with HDG options in addition to HDG tokens.
The options will be tokenized and provided through Zeta Markets’ derivatives platform. These options are American style, which means they can be exercised at any time on Zeta’s Flex UI.
The strike price for the options offered will be adjusted on a monthly basis and will start out of the money at the time when the strike price is set. The expiration will be set one year in the future, counted from the end of the month.
This is a new offering, so also be aware there’s some chance that we’ll adjust this rewards model as we monitor how liquidity providers respond.
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Offering options allows us to align the passion of our community with our long-term future. As the first Solana platform to offer this style of options as Liquidity Mining reward through Zeta Markets, we’re proud to be innovating with HDG.
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